Enterasys prosecution, defense state their cases

Published: November 9, 2006

For all its complexity, the case against five former executives of Enterasys Networks is a simple one involving “lying and cheating,” federal prosecutor William Morse told a panel of 17 jurors in his opening remarks Wednesday in US District Court in Concord.
The defendants may have had different roles in a conspiracy to violate accounting rules and inflate revenue in order to meet the company’s earnings targets in August 2001, as the company was being spun off from the former Cabletron Systems in Rochester.
But, similar to a “basketball team,” they all had “the common goal of the game … to deliver the numbers they couldn’t deliver,” Morse said. “At crunch time, the defendants didn’t play by the rules.”
However, while the prosecution tried to show a large criminal conspiracy involving at least nine people, the defense, in its opening arguments, maintained that there was no collusion. If all charges were broken down piece by piece, defendant by defendant, they would be seen as no more than common legitimate business practices. No one, all of the defense attorneys argued, had any desire to defraud or deceive anyone.
If this is a conspiracy, argued Bruce Singal -- representing Bruce Kay, Enterasys’ former vice president of finance -- “it was the oddest group of conspirators that you could ever imagine.”
Kay was on his way out, Singal said. He was demoted from CFO to be replaced by defendant Robert Gagalis.
Gagalis landed from Fisher Scientific with - in Morse’s words -- “both feet running.” But argued Gagalis’ attorney, James C. Rehnquist, he only arrived at Enterasys on July 19, and was immediately whisked away on a “road show” only to be back in the office on Aug. 2, less than a month before the quarter in question ended: Aug. 31, 2001.
The company was in a “state of flux” as it prepared for its spinoff from Cabletron, Rehnquist emphasized.
Similarly, defendant Robert G. Barber wasn’t even with the company. Although he worked for Cabletron for more than a decade, by the time of the alleged conspiracy he was a private contractor “outside looking in” and “essentially kind of hanging there” as a member of an investment team, according to his attorney, Richard McCarthy. Gagalis wanted him off the team, and defendant Jerry A. Shanahan became the chief operating officer, the job Barber wanted to keep.
Shanahan, for his part, argued his attorney Andrew Good, was only at Enterasys on a two-year contract. He was primarily concerned with production schedules and had nothing to do with accounting.
And several of the defendants hadn’t even met David Boey before the trial, since he was working in Singapore “on the other side of the planet,” said Singal.
So, in that context, what looks criminal in the government’s “cynical eye” is actually business as usual, argued Rehnquist.
For instance, the various defense attorneys also had their own interpretation of what Morse called “secret side agreements” that were “back-dated” in order to increase revenue. Several defense attorneys said that these were no more than clarifications and didn’t change the nature of the transaction. Boey, who is charged with physically altering the documents, did so only at behest of his superiors.
“There is nothing wrong with changing a document if the purpose is to clarify the agreement,” said Boey’s attorney, William Cintolo. “And he didn’t keep it from the auditors. It was in the file.”
When the auditors saw file, the company “locked him out of his office and threw him out of street,” said Cintolo.
Kay, for his part, didn’t even know about the side agreement, said Singal. He had tried to “put the brakes on the deal” by having it corrected before the quarter, and when he found out what happened afterwards “he was angry because it creates unnecessary red flags.”
Kay, said Singal, was a “straight shooter” who was criticized by Cabletron CEO Piyush Patel and others, for being too conservative when it came to pushing revenue.
Then there were the “three-corner deals,” in which Enterasys invested in small companies in exchange for that company buying Enterasys products through distributors. When Morse described such deals, he urged the jurors to “keep your eyes on the cash.” Enterasys was “buying its own revenue. The return of so called investments was sometimes a matter of hours after the cash went out the door.”
Then the company hid that fact from the auditors, Morse said.
But it was not unusual, maintained Rehnquist, for investing companies to insist that it buy back its products. Such “strategic alliances” often use distributors, or “channel partners.”
Barber was on the team “to find young companies that would be using Enterasys products,” but he was not concerned with how they were counted on the books, said McCarthy. That wasn’t his job.
Besides, McCarthy said, the company’s accountants - KPMG -- had known and approved such deals in the past.
Morse said that two accountants from KPMG will testify later in the trial. But the jurors should be skeptical, said Rehnquist, since they were under investigation themselves and would be eager to shift the blame elsewhere. Similarly, jurors should be wary of the testimony of four executives, including former CEO Enrique “Henry” Fiallo, who pleaded guilty to the accounting fraud, arguing that they would say anything to get out of jail time.
Morse, for his part, said that their words would be confirmed with various exhibits. The exhibits - primarily e-mails - would be the cement of the testimony, which is scheduled to start on today. - BOB SANDERS

This article appears in the October 27 2006 issue of New Hampshire Business Review